Wen Jiabao can say all he wants about U.S. Treasuries. But can he do anything?
The Chinese-official-says-something-worrisome-about-the-dollar-or-Treasuries scare has by now become a pretty regular market phenomenon. What was new about Prime Minister Wen Jiabao's blunt words today were that they were blunter than usual, and that they were being spoken by Wen Jiabao, not a "high-level state economist" or "the government's foreign exchange regulator." A sample:
We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.
He's right to be worried, not so much about whether the U.S. Treasury will make its payments but about how much the dollars in which those payments are made will actually be worth in the future. But what's he going to do about it?
The immediate answer is not much. China can't sell any significant part of its $1 trillion or so in Treasury and agency (Fannie-Freddie-Ginnie) debt without tanking the value of its remaining holdings. It's a variant on the old saw: owe the bank a thousand dollars and it's your problem, owe the bank a trillion dollars and it's the bank's problem.
At the same time, the status quo of the past 6 or 7 years, in which China runs gigantic trade surpluses with the U.S. and then lends the money back to the U.S. to keep American consumers buying, simply can't continue. Or maybe it can, but that would be a road to even bigger financial disaster than the one we're having right now.
I've now been pretty much persuaded by Martin Wolf's argument that unprecedented flows of capital from China and other big exporters into the U.S. (with unprecedent U.S. trade deficits as the flip side) were the single biggest cause of our current financial mess. Those global imbalances, as the aficionados call them, have got to be balanced out. There are two ways to do that (and I'm still mostly channeling Wolf here): One is for the nations of the world to stop trading with each other and investing in each other, which would wring out those global imbalances while also bringing on perhaps the worst global economic downturn ever. The other is for us and China and India and Japan and Western Europe and a bunch of other countries to figure out a way to keep the global economy going that doesn't involve U.S. consumers perpetually spending more than they earn and Asian economies perpetually making more than they consume. Which will, if successful, eventually lead to China buying far fewer Treasuries for Wen Jiabao to worry about.
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Hmmm. Your solution will also tank China's growth rate, which I suspect that Wen Jiabao would be more concerned about.
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The other is for us and China and India and Japan and Western Europe and a bunch of other countries to figure out a way to keep the global economy going that doesn't involve U.S. consumers perpetually spending more than they earn and Asian economies perpetually making more than they consume. Which will, if successful, eventually lead to China buying far fewer Treasuries for Wen Jiabao to worry about.
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Justin Fox adopts the Underpants Gnome theory of global financial stability...
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Step 1) China, US, Europe, Japan meet
Step 2) ?????
Step 3) Profits!!!!
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The real question is whether your assumption that a period of protectionism would be so horrible. The fact is that relatively few people accrue most of the rewards of "global trade", and the investments made in creating export based third world economies would have been far better utilized in creating sustainable growth within those countries.
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The US is now stuck on the horns of a dilemma -- we're in the midst of a recession, but because the US dollar is considered the world's most reliable currency, the value of the dollar has risen substantially, making investment in productive capacity overseas even more of a "bargain" relative to the US than it was before the economic meltdown.
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The only real solution is a period of protectionism. The US cannot be the economic engine of the world (let alone maintain a stable currency) unless its people have jobs, but US workers can't compete with developing world workers in terms of salary without those US workers becoming nearly as impoverished as those developing world workers.
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We are all going to wind up working in a gas station.
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@plukasiak: America cannot do everything competitive with the rest of the world; we never could. And what we can be competitive at shifts over time. Remember the opening of Snow Crash: America is better than the rest of the world at four things - movies, music, microcode (software development), and fast pizza delivery. As we came into the story, Hiro Protagonist was engaged in the last on the list.
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@plukasiak: You don't think the Underpants Gnome approach works?!? It's done just fine for the people at Hanes.
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That said, I don't think a period of modestly increased protectionism would kill us. But just in terms of arithmetic, the U.S. has been running a current account deficit of 6% of GDP. If we close it just by reducing imports, that's a huge negative shock for the world economy. If instead we close it through some combination of slightly decreased consumption here and increased consumption in Asia, everybody's better off. I didn't go into the ????? because it would have made the post go on forever and ever and gotten into levels of wonkiness way above my pay grade, but in the end it's a monetary fix. Martin Wolf talks about finding a way for Asian countries to borrow in their own currencies, so they no longer feel the need to build up huge stockpiles of dollars. Joe Stiglitz thinks the IMF needs to take on the role of central bank to the world, with its "special drawing rights" replacing the dollar as the world's reserve currency. And I'm just some guy who's apparently going to end up working in a gas station. -
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One common misconception I'm seeing in several articles on finance and economics starts off by saying, China's 2 trillion dollars of reserves amounts to a trifling day's worth of trading in the international currency markets. So, China could not "flood the international capital markets" with its dollar reserves. Hence, China cannot do much but worry about the value of its reserves.
A variant of this "China is helpless" argument is given by Justin Fox above: 'owe the bank a trillion dollars, and it is the bank's problem'. Moreover, people like Martin Wolf have argued that if China and other emerging economies do not like to keep their reserves in dollar they are free to switch to some other currency as the basis for trade between themselves.
However, China indeed has a workaround for this problem. Every time the US resorts to an expansionary monetary policy, China can resort to its own expansionary monetary policy, exactly to the extent that the dollar - yuan exchange rate remains stable.
An expansionary monetary policy by the US could set off inflation and debase the dollar's exchange rate value several months later (currently China, Japan and others step in to buy US treasuries to prevent inflation). China is not helpless in this situation. China can print more of its own currency to keep the dollar from falling too much against the Yuan. In fact, China has resorted to this exact approach to finance its own $586 billion fiscal spending program.
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That said, I don't think a period of modestly increased protectionism would kill us. But just in terms of arithmetic, the U.S. has been running a current account deficit of 6% of GDP. If we close it just by reducing imports, that's a huge negative shock for the world economy.
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I'm not saying reduce all imports -- banana, for instance, we'll still need to import.
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But we need to start making stuff again (like cars, and clothing -- its rather insane for us to export cotton to be sewn overseas to make clothes for US consumers...except that clothing companies for workers in underdeveloped countries to work in unsafe sweatshops for pennies a day. ) -
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"But can he do anything?"
By making statements like he did he raises the question, will China buy more Treasuries? Does China want to finance part of Obama's social agenda? Obama says it is vital to our economic future, but will our debtors feel that way as well?
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